Unequal Partners

David Hunter stood before his 24 employees and presented them with a cake decorated to look like a stock certificate. It was May 1983, and BI Inc. had just raised $2.5 million by selling 40% of the company to the public. As president of BI, Hunter seemed to have good reason to celebrate. But even as he declared that they were going to make BI "the best dairy-electronics company in the country," Hunter was starting to worry that "we'd soon be history."

Like all of agriculture, the dairy industry was showing signs of turning sour in 1983. Soon BI would need more money to develop new products. Borrowing was out of the question; the company was already in the red. Venture capitalists wanted more equity than Hunter was ready to give up. And an R&D limited partnership was too costly. Where, then, to turn?

Big companies seemed to be the answer. Through newly formed venture funds, these giants appeared willing to invest money with no strings attached. By pursuing this strategy, BI would not have to take on any debt. Nor would it be forced to surrender much equity. But it would ultimately give up something even more precious: control. BI came to have very little say in the matter of its own destiny. Which is why, four years and many deals later, David Hunter is managing what is essentially still a start-up. He can count more dashed hopes than new products. "Big companies are not a panacea," says Hunter, 42. "Behind every big company is an alley filled with the carcasses of small companies."

Those alleys are likely to get more crowded. Until 1980, there were only about 30 deals a year in which big companies bought minority stakes in small, venture-backed businesses. By 1984, when Hunter embarked on his plan, that figure had jumped to 304. Last year, about 360 so-called strategic alliances were formed, with small companies gaining access to cheap capital and big companies getting a relatively inexpensive peek at new technologies, products, and markets.

There's only glitch: three-quarters of them don't work out, according to Mark Radtke, vice-president of Venture Economics Inc., a firm that bracks such alliances. "The big company can be gung ho one day and lose interest the next," Radtke says. "It's a common complaint. And, unless the small company screams and yells, it never gets heard." As David Hunter discovered, even screaming and yelling isn't enough.

Hunter's decision to reach for help from big companies came naturally enough. BI owed its early fast-track growth to Alfa-Laval Inc. The giant Sweden-based agricultural concern had seen potential in BI's technology, which uses radio frequencies to create electronic-identification systems. Alfa-Laval had paid BI $288,000 to perfect an electronic feed-management system for dairy cows, and the company had taken off. Sales soared from more than $900,000 in 1983 to $1.8 million the next year. Profits year moving just as quickly -- but in the other direction. BI posted losses of about $481,000 in 1983, which then slid even further to $592,000 in 1984. Hunter admits he made some mistakes. He had wanted the Alfa-Laval deal so badly that he made promises BI couldn't keep. Developing the product turned out to be $100,000 more expensive than Hunter had anticipated, and it took three months longer than expected.

No matter. Start-ups make all kinds of mistakes. The deal had enabled BI to survive, and it left the company with a positive feeling about big companies as partners. Besides, a less desperate and more experienced Hunter would be in a better position to negotiate new deals, and would be better at estimating costs and timetables. This time, Hunter thought, his business wouldn't be a naive start-up reaching out for its only hope. It was now a growing company looking to capitalize its diversification through big companies.

That's easy to say. But it's hard for a small company to keep its composure when it hears a big company knocking at the door. Hunter, for one, was excited when he heard that executives from Eli Lilly & Co., the pharmaceutical giant, wanted to visit BI's headquarters in Boulder, Colo. It was late 1984, a year and a half after the public offering. On the day the two Lilly executives came to call, Hunter hurried out to their car. Along with Gary Carroll, one of BI's founders, he stood in the slushy snow and pumped their arms in welcome.

Once inside, the representatives of Lilly's animal-health division asked about potential products. One idea Hunter camp up with was to develop an identification system for farm animals. He could foresee all kinds of farmers wanting such systems to weed out unproductive animals. While they talked, Hunter saw a vertical integration opportunity for BI, fully funded by Lilly. He was dazzled by their colorful 30-minute slide show about the company.

Hunter is not the first small-company president to think the giants have all the answers. In truth, though, that may mean only that the small company isn't asking enough questions.

And no matter how excited the larger partner may seem, it isn't likely to act quickly. For about three months, BI was at the mercy of every zig and zag within Lilly. Finally, David Putman, who then handled technology acquisitions for Lilly, told Hunter that his chances of getting a deal were about 99%, with just one more executive needed to sign off on it. Putman was BI's advocate within the big company, and Hunter completely relied on him -- too much, as he would soon find out. A few weeks later, Putman's story changed completely: the deal was dead. Unhappy with the prospective return, that last executive had axed it. "It was a heartbreaker," recalls David Hatfield, BI's former vice-president of finance and planning. "It really took the wind out of our sails."

Inside Lilly, as in any big company, various groups, programs, and divisions were competing for resources. As Hunter learned, capturing the imagination of one individual or group isn't the same as securing a deal. "There was a lot of internal politicking," he says. Nevertheless, he hopped on a plane at six a.m. the day after hearing the bad news. He wanted to see if he could revive Lilly's interest, and he succeeded. Lilly reversed itself and agreed to a slightly altered deal. It took another two months before the contract was signed: Lilly paid $360,000 for 3.2% of the company and another $140,000 for BI to continue to make its technology cheaper and smaller. Getting Lilly to buy equity was key to BI's startegy. "We figured if things got rough, they'd put in another $500,000 rather than see their initial investment blown away," says Dick Brummer, who manages BI's eastern regional office.

But a big company that buys equity is by no means making a tacit agreement to keep its smaller partner alive. Half a million dollars is an easy write-off for Lilly, a $3-billion company. Hunter found that out six months later, in the fall of 1985, when he went back for more money. BI's dairy business was starting to collapse; it would be down 60% by the end of the year. "We were hanging by a whisker," he admits.

He brought Lilly the customized chip BI had developed with Lilly's funds. How about using this in a system for identifying pigs? he asked. BI would manufacture it, and Lilly could help with marketing. Lilly even took the discussions several steps further. The executives talked about an entire product line; even an acquisition didn't seem that remote. "They said, 'We're going to put this on every pig in America," Hunter recalls. "We felt the souffle was rising."

Then somebody flattened it. Putman, BI's staunchest advocate inside Lilly, "handed the baton over and the relationship cooled off immediately and directly," Hunter says. We have to think it over more, he started hearing; we're not sure we like the returns. It had never been clearer to Hunter that having "a champion with vision is most important."

It was a lesson he would apply to BI's next alliance. Just being a good strategic fit was not enough. And neither was selling equity. To keep the big company's attention, BI would have to have more than one champion. And it had to look for many ways to hold the big company's interest.

In 1985, just as the Lilly deal was starting to cool, Control Data Corp.'s interest in Home Escort, a product BI had been working on, was heating up. Designed to ease prison overcrowding by allowing inmates to be supervised at home, Home Escort is an ankle bracelet containing a radio transmitter. The transmitter keeps track of the offender's whereabouts by sending signals over telephone lines to the appropriate law-enforcement agency. Control Data, which was already selling educational materials to prisons, was looking for more products to sell through its corrections-services division.

This time, Hunter cultivated more than one contact. Control Data was willing to buy equity: 2.8% of the company for $300,000. But the clincher, Hunter felt sure, was that BI sold Control Data on the idea of buying exclusive marketing rights to the product. "They thought, 'If we give the big company the exclusive, then we'll get more attention from them," recalls Vernon Sieling, who was then senior vice-president for special markets at Control Data. The tactic backfired badly, but at first it seemed to work. Control Data sold a system to the state of Michigan. Then to Utah. It designed brochures, videotapes, and display booths.

But BI was making itself completely dependent on Control Data in developing the Home Escort market. By giving up the exclusive rights, it gave up any other distribution channels. And BI didn't know that, from Control Data's view, BI's Home Escort was just one of many unprofitable products. Again, no one was asking enough questions. BI was much more vulnerable than it realized.

By the beginning of 1986, Control Data hadn't yet signed the most lucrative part of the deal for BI, a minimum-purchase agreement. In mid-January, Hunter and Brummer went to Minneapolis to put the finishing touches on that multimillion-dollar contract. During the plane ride, they planned a big party that night to "show Control Data the personal side of BI."

The two walked into Sieling's thirteenth-floor office. Before we start, Sieling said, I'd better show you this letter. The first sentence read, "Control Data has made a strategic decision to cease marketing the . . . Home Escort." Caught in the computer slump, Control Data had decided to refocus on its core computer business. "I knew it was going to be a gut wrencher for them," says Sieling, now retired. "It was just starting to roll. But we had to go out of the business. It had nothing to do with the alliance itself."

A few days later, Hunter called a board meeting. Both Lilly and Control Data had let the company down. True to Hunter's thinking, the companies had parted with capital cheaply. Through Control Data and Lilly, BI had received $660,000 for 6% of the company and another $140,000 for technical development. (The public market valued the total company at only about $5 million.) Those deals had sustained BI, but it was still a manufacturing company with very little to make. Hunter had to lay off 11 of 32 workers.

But he still had one more major Fortune 500 player up his sleeve: Borg-Warner Corp. About a year earlier, the Chicago-based industrial concern had contacted BI. Hunter believed it was interested in applying BI's technology to the manufacture of auto had a protective-services group, and, along with a board member, he visted the company. By the end of June 1986, Borg had in principle agreed to step in. It would put $1 million toward BI's Home Escort product for a small percentage of equity.

Hunter by now felt uneasy about relying on a big company. And Borg-Warner was not an ideal strategic fit. It was in the protective-services business, but it didn't sell to the corrections markets that BI needed. Of course, a company with the money to spend can always build a market from scratch. "Borg-Warner offered the deep pockets needed to create a market," says George Pilmanis, a BI board member. But BI knew it was an expensive proposition.

Despite Borg-Warner's interest in BI, Hunter needed something to calm his nerves: a contingency plan. With all the media attention that the home-incarceration product was generating, he thought he might be able to round up some private money. He was right; the complicated technology suddenly seemed glamorous. He lined up local investors with a total of $600,000. That would be enough to keep Home Escort afloat if Borg sank the deal -- not that anyone really expected that. In July, the board unanimously approved Borg's conditions, and urged Hunter to seal the alliance within two weeks. A month passed, with Borg hesitating to schedule a final meeting. That was OK. BI had learned that its time frame was eons apart from any big company's. "A year to them is a month to us," says Hunter.

Then one day in August, McKinley "Bud" Edwards Jr., BI's vice-president of operations, picked up his morning paper and read that Borg-Warner was buying back chunks of stock. Perhaps, Edwards thought, Borg was involved in a takeover fight. He marched next door into Hunter's office. We may have the answer here, he suggested. Hunter called Donald Hoeg, head of Borg-Warner's research division. "This takeover is totally preoccupying the corporate mind here," Hoeg told him. "Borg is not going to do a thing with BI for at least six months." The giant company was too busy protecting itself by buying back stock and restructuring. "I would have liked to see the deal go through," laments William Weltyk, then corporate vice-president of technology at Borg-Warner. "But doing deals with smaller companies becomes a secondary priority to some other pressing problems."

Hunter couldn't stand any more. After taking $600,000 from the private investors, he raised another $500,000 early this year. "We are going to control our own destiny," he says. He hired Jonathan Hinebauch to set up a distribution system for the home-incarceration product. Hinebauch, the company's first vice-president of marketing, vows to get the product out "with no entangling alliances." Adds Hunter: "You can't make big companies the only game in town."

But Hunter can't quite give up on them, either. They have been a rich source of capital for BI -- even if the company still looks like a start-up. BI has cautiously signed two development deals with Baxter Travenol Laboratories Inc. The health-care company is interested in using BI's technology in the medical field, a potentially huge market. Will Baxter be able to turn BI, at last, into a profitable manufacturing company? "They'll disappoint us," says Hunter bitterly. "But I'm sure they'll do it a lot differently."